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Europe’s three psycho-battles

Spectre of ‘winner takes all’ in north-south split

By David Marsh

(This article can be found in the February Commentary section on OMFIF.org)

Three psychological battles over Europe’s future come to a head in the next few weeks, setting daunting challenges particularly for Angela Merkel, the German chancellor, David Cameron, the British prime minister, and Mario Draghi, president of the European Central Bank.

There is a broadly comparable north-south split among allies and combatants in the three tussles – over migration into Europe from neighbouring conflict zones, the terms of Britain’s referendum over EU membership, and the ECB’s next monetary easing to boost the economy and weaken the euro. So whoever emerges victorious from Europe’s war of nerves may achieve ‘winner takes all’ status – while losers could be defeated across the board.

Merkel hopes a combination of administrative controls, better policing, enhanced co-operation with other EU states and more effective patrolling of sea passages between Turkey and Greece will reduce migrants flooding into Germany ahead of crucial state elections on 13 March.

Entries into Germany fell to just over 91,000 in January, less than half the November level – although this may largely be due to freezing winter weather. Berlin officials expect an underlying rise in arrivals in coming months as desperate refugees make a last-ditch effort to reach German ‘promised land’ ahead of frontier clampdowns.

Cameron will watch for signs that EU concessions on British demands – ranging from migrants’ benefits to safeguards for Britain’s non-euro area status in a EU ‘multicurrency bloc’ – will translate into better opinion poll data ahead of the referendum pencilled in for 23 June.

A Brussels European leaders meeting on 18-19 February is expected to enshrine improvements that Cameron hopes will favour the ‘stay in’, despite a virulent British press campaign against the prime minister’s alleged negotiating shortcomings.

However, as Jacques Lafitte and Denis MacShane write in an OMFIF commentary tomorrow, the UK row over migrants obscures a much larger dispute over a Europe-wide redistribution of economic standing and industrial and financial jobs if the UK leaves the EU.

The third conflict – over the ECB’s plans for further cuts in negative interest rates and higher quantitative easing monthly bond purchases from €60bn to €80bn to combat low inflation – is furthest from the headlines but could be the most explosive. Pressure is building within the ECB’s governing council to head off expected easing at the next policy meeting on 10 March, in view of widespread feeling that low inflation is predominantly due to weak world oil prices that the ECB cannot control.

Opposition to Draghi’s stated policy of sticking closely to the ECB’s mandate of achieving near-2% inflation over the medium term is led by the German and Dutch central banks, but appears to be growing among the 19 euro members. Although the ‘hawks’ are still well short of a council majority, they are sharpening their talons. The opposition focuses on the outlook that, in March 2017, the ECB and its constituent central banks will own more than 25% of all euro area government debt, subverting the Maastricht treaty ban on monetary financing and reducing pressure on governments to curb borrowing.

The three thorny issues are interlinked. British EU membership, and the prospect that a British No could set off further disintegration, are now a matter for the highest level of European monetary policy-making.

The countries most worried about a British exit are largely from the northern and central-eastern European states most hawkish about interest rates and migration curbs. In view of these interlinkages, a breakthrough on one set of questions could exacerbate Europe’s north-south creditor-debtor divide. Doubts about the ECB’s commitment to further easing, as well as signs that the US will be less aggressive in interest rate hikes, have led to the euro strengthening this year against the dollar. This is highly unwelcome to the ECB which informally reckons the main impact of QE lies in weakening the currency – part of a worldwide trend towards competitive devaluations that is highly uncomfortable for the ECB’s hawks and forms one of the gravest weaknesses of the world economy.